In this arrangement, a country sticks some amount of money in another country called the anchor. The local currency is backed by supply of a foreign currency from the anchor country at a fixed rate thus enabling it operate as a hard currency (Hubik 212). This means that the currency board will only issue money basing on the foreign currency thus the question of inflation is no longer existent. Increased deposits of local banks in the central bank are obtained because of a surplus in the balance of payments. Economic stability it attained and maintained so easily when these parameters are used appropriately.
This is one of the most powerful tools of stabilizing the economy using monetary means. The central bank of a country may choose to avail money to local bank at a higher interest rate than normal (Sorin 122). This sees an increase in the lending interests too which discourage borrowing and encourages saving. The overall effect is reduction of the currency in circulation and vice versa thus controlling inflation rates.
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